Published and Forthcoming
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1. The Price of Flexibility: Towards a Theory of Thinking Aversion
Journal of Economic Theory, Vol. 148, No. 3 (May 2013), 903--934
Idea: Model an agent who prefers a smaller menu because of the cost of thinking involved in choosing from the bigger one. Defines a notion of Thinking Aversion, and characterizes this cost.
Abstract: We study the behavior of an agent who dislikes large choice sets because of the ‘cost of thinking’ involved in choosing from them. We take as a primitive a preference relation over lotteries of menus and impose novel axioms that allow us to separately identify a ‘genuine’ preference over the content of menus from the cost of choosing from them. Using this, we formally define the notion of Thinking Aversion, much in line with the definitions of risk or ambiguity aversion. We characterize such preference as the difference between an affine evaluation of the content of the menu and a function that assigns to each menu a thinking cost. We provide conditions that allow us to interpret the cost of thinking about a menu as the cost that the agent has to sustain to figure out her preferences in order to make her choice.
2. Modeling the change of Paradigm: Non-Bayesian Reaction to Unexpected News
American Economic Review, Vol. 102, No. 6 (October 2012), 2410--2436.
Idea: A model in which agents are Bayesian after `normal' events, but have non-Bayesian reactions to low probability events, and whose behavior is modeled also after zero-probability ones.
Abstract: Bayes' rule has two well-known limitations: 1) it does not regulate the reaction to zero-probability events; 2) a sizable empirical evidence documents systematic violations of it. We introduce a behavioral rule, Dynamic Coherence, and show that it is equivalent to an alternative updating rule, the Hypothesis Testing model. According to it, the agent follows Bayes' rule if she receives information to which she assigned a probability above a threshold. Otherwise, she looks at a prior over priors; updates it using Bayes' rule for second-order priors; and chooses the prior to which the updated prior over priors assigns the highest likelihood. We apply the model to construct, in an example, a refinement of Perfect Bayesian Nash Equilibrium.
3. Incomplete Preferences under Uncertainty: Indecisiveness in Beliefs vs. Tastes (with Efe Ok and Gil Riella)
Econometrica, Vol. 80, No. 4 (July, 2012), 1791–1808
Idea: Studies incomplete preferences under uncertainty.
Abstract: We investigate the classical Anscombe-Aumann model of decision-making under uncertainty without the completeness axiom. We distinguish between the dual traits of "indecisiveness in beliefs" and "indecisiveness in tastes." The former is captured by the Knightian Uncertainty model, while the latter by the single-prior expected multi-utility model. We characterize axiomatically the latter model. Then, we show that, under Independence and Continuity, these two models can be jointly characterized by a means of a partial completeness property.
4. Status Quo Bias, Multiple Priors and Uncertainty Aversion
Games and Economic Behavior, Vol. 69 (2010), pp. 411-424
Idea: Characterize status-quo-dependent preferences under uncertainty. The agent keeps her status quo unless there is an option better than it for a set of priors. We also show that this implies that the agent is uncertainty averse.
Abstract: Motivated by the extensive evidence about the relevance of status quo bias both in experiments and in real markets, we study this phenomenon from a decision-theoretic prospective, focusing on the case of preferences under uncertainty. We develop an axiomatic framework that takes as a primitive the preferences of the agent for each possible status quo option, and provide a characterization according to which the agent prefers her status quo act if nothing better is feasible for a given set of possible priors. We then show that, in this framework, the very presence of a status quo induces the agent to be more uncertainty averse than she would be without a status quo option. Finally, we apply the model to a financial choice problem and show that the presence of status quo bias as modeled here might induce the presence of a risk premium even with risk neutral agents.
Working Papers (by topic)
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5. Cautious Expected Utility and the Certainty Effect (with Simone Cerreia-Vioglio and David Dillenberger)
Idea: Novel class of preferences that satisfy the Certainty Effect (Allais Paradox) in which the decision maker has a set of utilities and considers the most pessimistic one of them. Characterized via one key axiom, Negative Certainty Independence (plus basic axioms).
Abstract: Many violations of the Independence axiom of Expected Utility can be traced to subjects' attraction to risk-free prospects. Negative Certainty Independence, the key axiom in this paper, formalizes this tendency. Our main result is a utility representation of all preferences over monetary lotteries that satisfy Negative Certainty Independence together with basic rationality postulates. Such preferences can be represented as if the agent were unsure of how risk averse to be when evaluating a lottery p; instead, she has in mind a set of possible utility functions over outcomes and displays a cautious behavior: she computes the certainty equivalent of p with respect to each possible function in the set and picks the smallest one. The set of utilities is unique in a well-defined sense. We show that our representation can also be derived from a `cautious' completion of an incomplete preference relation. be derived from a `cautious' completion of an incomplete preference relation.
6. Allais, Ellsberg, and Preferences for Hedging (with Mark Dean)
(Previous Title: Objective Lotteries as Ambiguous Objects: Allais, Ellsberg,and Hedging)
Idea: Model an agent who exhibits both Allais and Ellsberg-like behavior in the setup of Anscombe and Aumann (1963). Generalizes Gilboa and Schmeidler (1989) to allow for Allais-type behavior.
Abstract: We study the relation between ambiguity aversion and the Allais paradox. To this end, we introduce a novel definition of hedging which applies to objective lotteries as well as to uncertain acts, and we use it to define a novel axiom that captures a preference for hedging which generalizes the one of Schmeidler (1989). We argue how this generalized axiom captures both aversion to ambiguity, and attraction towards certainty for objective lotteries. We show that this axiom, together with other standard ones, is equivalent to two representations both of which generalize the MaxMin Expected Utility model of Gilboa and Schmeidler (1989). In both, the agent reacts to ambiguity using multiple priors, but does not use expected utility to evaluate objective lotteries. In our first representation, the agent treats objective lotteries as `ambiguous objects,’ and use a set of priors to evaluate them. In the second, equivalent representation, lotteries are evaluated by distorting probabilities as in the Rank Dependent Utility model, but using the worst from a set of such distortions. Finally, we show how a preference for hedging is not sufficient to guarantee an Ellsberg-like behavior if the agent violates expected utility for objective lotteries. We then provide an axiom that guarantees that this is the case, and find an associated representation in which the agent first maps acts to an objective lottery using the worst of the priors in a set; then evaluates this lottery using the worst distortion from a set of convex Rank Dependent Utility functionals.
(Previous Title: Rational Choice with Endogeneously Determined Reference Points: The Case of the Attraction Effect)
Idea: Characterize choice that violate Warp because of an endogenous reference point, like in the case of the attraction effect.
Abstract: The goal of this paper is to develop, axiomatically, a revealed preference theory of reference-dependent behavior. Instead of taking the reference for an agent as exogenously given in the description of a choice problem, we suitably relax the Weak Axiom of Revealed Preference and we the existence of reference alternatives as well as the structure of choice behavior conditioned on those alternatives.
8. Hypothesis Testing and Multiple Priors (Note)
Idea: Short note that extends the Hypothesis Testing model to the case of ambiguity averse agents.
Abstract: We extend the Hypothesis Testing model of Ortoleva (2010) to the case in which the agent is ambiguity averse both before and after she receives information. In particular, we model an agent who ranks acts according to the MaxMin Expected Utility model of Gilboa and Schmeidler (1989), where the set of priors is chosen as follows. If the agent receives an information to which each prior in her set assigns a probability above a threshold, then she updates every prior in the set using Bayes' rule. Otherwise, she: looks at a prior over sets of priors; updates it using a rule similar to Bayes' rule for second order beliefs; finally, chooses the set of priors to which the updated prior over sets priors assigns the highest likelihood.
9. Hypothesis-Testing model with an Infinite State Space (Note)
Idea: Short note that extends the Hypothesis Testing model to the case of an infinite state space.
Abstract: We extend the Hypothesis Testing model of Ortoleva (2010) to the case in which the state space is infinite. We show that almost identical results hold in this case as well.
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10. Estimating the Relationship between Economic Preferences: A Testing Ground for Unified Theories of Behavior (with Mark Dean)
(Previous title: Is it All Connected? Understanding the Relationship Between Behavioral Phenomena )
Idea: Studies with an experiment the empirical relation between behavioral phenomena like risk, ambiguity, and loss aversion, certainty, present, and status quo bias, endowment effect, updating speed, discounting, etc.
Abstract: We consider 12 economic behaviors that have been identified by behavioral economists, measure them in a group of subjects, and estimate the empirical relationship. We find five factors that explain much of the variance in behavior, relating to: violations of expected utility (EU) in risky choice; ambiguity and compound lottery aversion; loss aversion and the endowment effect, time preferences and social preferences. Underlying this broad picture, we find many additional relationships: notably, ambiguity aversion is related to violations of EU in risky choice, the endowment effect, and loss aversion; risk aversion to discounting; and overconfidence (overplacement) to ambiguity aversion.
11. Multidimensional Ellsberg (with Kfir Eliaz)
(Previous title: A Variation on Ellsberg and Uncertain Probabilities vs. Uncertain Outcomes: An Experimental Study of Attitudes Towards Ambiguity)
Idea: Modifies Ellsberg experiments to allow for bet directly on the composition of the urn. The behavior observed suggests of restrictions of the set of priors.
Abstract: The classical Ellsberg experiment presents individuals with a choice problem in which the probability of winning a prize is unknown (ambiguous). In this paper, we study how individuals make choices between gambles in which the ambiguity is in different dimensions: the winning probability, the amount of the prize and the payment date, and many combinations thereof. While the decision-theoretic models accommodate a rich variety of behaviors, we present experimental evidence that points at a systematic behavioral pattern: (i) no ambiguity is preferred to ambiguity on any single dimension and to ambiguity on multiple dimensions, and (ii) “correlated” ambiguity on multiple dimensions is preferred to ambiguity on any single dimension.
12. Stochastic Choice and Hedging (with Marina Agranov)
Idea: Experimental paper in which we show that the majority of subjects choose to give a stochastic choice. This is in line with the interpretations of stochastic choice as emerging from an explicit preference for hedging, as opposed to emerging from random utility or mistakes.
Abstract: One of the most consistent finding of human decision making is that subjects often make different choices from the same set of options – a phenomenon referred to as stochastic choice. Several interpretations have been proposed to account for such behavior. Amongst them: random expected utility; mistakes; and a preference for hedging, i.e., subjects randomize on purpose. We design a controlled laboratory experiment to distinguish between these theories in a standard framework of choice over lotteries. Our experiment implements two novel features: 1) a part in which subjects are explicitly told about the repetition; 2) a part in which subjects are given the additional option to use a (costly) randomization device to choose between the lotteries. We find that the Random EU and the Mistakes interpretations together cannot account for the behavior of the majority of subjects, and that a large number of them have a behavior compatible with the Hedging interpretation. This preference for randomization is related to the tendency to exhibit Allais-like violations of EU and is independent of the risk attitudes of subjects.
Download: Paper in PDF (April 2013)
Political Economy, Behavioral Economics and Applications of Decision Theory models:
13. Confidence and Overconfidence in Political Economy (with Erik Snowberg)
Idea: Studies the role of overconfidence in ideology formation and voting, showing how it is linked with ideological extremism and higher turnout. It then tests the predictions in novel survey data, finding a strong support.
Abstract: This paper studies the role of overconfidence in political behavior. We posit a simple model of overconfidence in beliefs. The model predicts that overconfidence leads to ideological extremeness, increased voter turnout, and increased strength of partisan identification. Moreover, the model makes many nuanced predictions about the pat- terns of ideology in society, and over a person’s lifetime. These predictions are tested, using novel survey data that allows for the measurement of overconfidence, and are found to be statistically and substantively important.
Download: Paper in PDF (September 2012)
14. The Behavior of Others as a Reference Point (with Francesco Bogliacino)
(Previous title: Aspirations and growth: a model where the income of others acts as a reference point, and The Behavior of Others as a Reference Point: Prospect Theory, Inequality, and Growth)
Idea: Study growth when the average consumption of the society acts as a reference point for the consumers. Reference dependence is modeled using prospect theory.
Abstract: We study a model in which consumers are reference-dependent, modeled using prospect-theory, and their reference point is the average behavior of the society in that period. We show that in any of the equilibria of the economy after a finite number of periods the wealth distribution will become, and remain, either of perfect equality, or admit a missing class, a particular form of polarization between the rich and the poor. We then study growth rates and show that, if we look at the equilibria with the highest growth, then the society with the highest growth rate is the one that starts with perfect equality. If we look at the equilibria with the lowest growth, however, then the society with a small amount of initial inequality is the one that attains the highest growth rate, while a society with perfect equality is the one with the lowest performance. All of these growth rates are weakly higher than the growth rate of a corresponding economy without reference-dependence.
15. Theory of Product Differentiation in the Presence of the Attraction Effect (with Efe Ok and Gil Riella)
Idea: Applies the model of "Revealed (P)Reference Theory" to the theory of product differentiation. Obtains that the presence of these biases might lead the economy back to an efficient equilibrium in which the monopolist extracts all the surplus.
Abstract: We apply the theoretical model of endogenous reference-dependence of Ok, Ortoleva and Riella (2011) to the theory of vertical product differentiation. We analyze the standard problem of a monopolist who offers a menu of alternatives to consumers of different types, but we allow for agents to exhibit a form of endogenous reference dependence like the attraction effect. We show that the presence of such biases might allow the monopolist to overcome some of the incentive compatibility constraints of the standard problem, leading the economy back towards the efficient equilibrium in which the monopolist extracts all the surplus. We then discuss welfare implications, showing that an increase in the fraction of customers who are subject to the attraction effect might not only increase the monopolist’s profits and total welfare, but consumer’s welfare as well.
16. Thinking Aversion and Portfolio Choice
Idea: Apply the model in "The price of Flexibility" to a portfolio choice.
Abstract: This paper analyzes the investment decision of an agent who has to figure out the correct model to use in order to evaluate all available assets. This is a costly process. She can choose either to endure this cost, or to simplify her choice by looking only at a subset of the available assets. We show that such an agent tends to participate less in the market, to under-diversify her portfolio, or to diversify it naively, by investing equal amounts in a selection of assets. These predictions qualitatively match the empirical observations of the investments of households, both in general investment situations and in the choice of 401(k) plans. Moreover, in a partial equilibrium setting, if agents are not aware that others bear the cost of discovering which model to use, then even a small cost can induce a sizable effect on the equilibrium prices. This is due to a phenomenon similar to a multiplier: agents observe prices that are different than expected, and in turn modify expectations, which affect prices, which in turn affect expectations, and so on.
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